An increasingly assertive US foreign policy and a strengthening US dollar have contributed to a global sell-off in emerging markets (EM), with Turkey and Latin America among those suffering the biggest falls.
EM ETFs in global sell-off
Exchange-traded funds tracking Turkish equities are down almost 15% over the month, and ETFs linked to Mexico and Latin America are down about 10% and 6% respectively.
ETFs on Indonesia and Vietnam have also been hit.
Alongside this, flows into EM ETFs have also reversed, with Europe’s largest EM ETF, the iShares Core MSCI EM IMI UCITS ETF USD (Acc) (EIMI LN), experiencing its first redemption (reduction in shares in issue) since August 2015.
Market commentators are attributing the stockmarket losses and ETF outflows to a strong US dollar, which pushes up the cost of borrowing for emerging markets and harms those with significant debt denominated in USD.
The US dollar has risen for a couple of reasons.
President Trump’s recent decision to pull out of the Iranian nuclear agreement will reduce the amount of oil that Iran exports to the US – it is estimated that the move will keep up to half of Iranian oil in the ground. This, along with the geopolitical uncertainty it causes, has lifted the price of oil. Higher oil prices will result in the US producing more domestically as more operations become economical, and importing less. This reduction in imports puts upward pressure on the US dollar.
Since the US departure from the deal was announced, crude oil prices have risen to a three-year high.
The other upward pressure on the US dollar comes from the Federal Reserve’s quantitative tightening programme. Dollar liquidity has fallen which has made it more attractive to foreign investment, pushing the currency up.
Turkey is one of the most vulnerable emerging markets to US rate rises and the country’s sovereign rating has recently been downgraded by Moody’s from Ba1 to Ba2. The reason for the downgrade was cited as a continued loss of institutional strength and an increased risk of external shock given its wide current account deficit. The Turkish lira has fallen following the release of higher-than-estimated current account deficit data.
The Lyxor Turkey (DJ Turkey Titans 20) UCITS ETF (TURU LN) has fallen 15.8% over the past month and is down 22.4% year to date. It tracks the Dow Jones Turkey Titans 20 Index, which measures the largest and most liquid stocks traded in Turkey.
The three-month Libor rate, a short-term borrowing benchmark, has climbed to a 10-year high of 2.36%. This is expensive for emerging markets who borrow in US dollars to invest in higher-yielding emerging market currencies. Most EM debt is US dollar denominated.
This has affected Latin America ETFs such as the Xtrackers MSCI Mexico Index UCITS ETF (DR) (XMES LN) and the iShares MSCI EM Latin America UCITS ETF USD (Dist) (DLTM LN), which have fallen 9.5% and 6.5% respectively this past month.
In other political tensions, the potential formation of a eurosceptic Italian government by anti-establishment Five Star and far-right League has put downward pressure on the euro. The yield on Italy’s 10-year bond has risen to 1.9%, a six-week high. Investors are concerned about these populist parties forming a government. This increases the attraction of euro debt relative to EM debt.
All of this has spelt bad news for emerging markets. And with data pointing towards continued dollar appreciation, EM ETF investors would be wise to brace themselves for ongoing turbulence.